What is Simple Interest Mortgage?

In a simple-interest mortgage home loan, interest is calculated daily. In a standard mortgage, it is calculated monthly. If a consumer thinks they may want to get a simple-interest mortgage, they should first compute the total costs of both loans. When the two different loans are compared, borrowers will pay more on interest in a simple-interest loan than they would on a standard mortgage.

In addition, the amount due can go up or down with either loan if payments are made early or late. However, for the purposes of this article, we will only discuss loans where payments are made on time each month. With a standard or a simple-interest mortgage for $100,000 with a 30-year term at a rate of 6%, payments toward the primary amount come out to $599.56. Interest, however, is computed differently for the two mortgage types. On the standard mortgage, the 6% is divided by 12 (the number of months in a year), which equals a monthly rate of 0.5%. For a simple-interest mortgage, the 6% is divided by 365 (the number of days in a year). (Leap years affect this calculation slightly, of course.) The daily rate of interest is therefore 0.016438%. As a result, with a 30-year standard mortgage for $100,000 at a rate of 6%, the total amount due is $115,832. With a simple-interest mortgage, with payments made on the first day of every month, the consumer would pay off their loan 41 days later at a total of $116,167. Therefore, in this example, the simple interest mortgage costs $335 more than a standard mortgage.

In most cases, a standard mortgage is considered a better investment for the individual than is a simple-interest mortgage. On the simple-interest mortgage, in contrast, the allocation between principal and interest depends on the day the payment is credited. Any delay in the payment raises the part going to interest and reduces the part going to principal by the same amount. If the payment in the example is late by seven days or more, interest will absorb the entire payment and there will be no reduction in the balance.

1. Simple-interest mortgages Have Late Charges: Since interest on a simple-interest mortgage is charged daily, there is no rationale for a late charge, but lenders impose one anyway -- because they can. A late fee on a standard mortgage is completely reasonable, but late fees on simple-interest mortgages are an abuse.